U.S. ECONOMIC NUMBERS SHOW DECLINE OF 0.3% GDP IN Q3 2008
The facts probably indicate that the recession/depression actually began in the fourth quarter of 2007 or early in 2008. Since that time, we expect that real GDP has shrunk by about 4% from its peak. Before the current economic correction is over, we expect to see peak to trough economic growth shrink by at least 10%…and the economic shrinkage will last from late 2007 through 2009.
The facts as we see them:
1. Those who work in government like to please their bosses. Statistics gatherers who work in government, like to show data which make the politicians look good.
2. The Bush administration has tried to make the economy look stronger using selective and ad hoc economic adjustments. We have long thought that after the election, the economic statistics would become decidedly less positive, as they adjust for the over statements in growth in the period from December 2007 through June 2008.
3. Most observers agree that the Democrats will be the big winners in this week’s U.S. election. As soon as they are able, we expect government statisticians to emphasize the negative statistics so that the new administration will be able to say, “Look what we inherited…and how well we have done improving the situation”, once the data begins to look better.
4. We expect that the fourth quarter 2008 and first quarter of 2009 data will look bad when it comes out.
OUR ECONOMIC VIEWPOINT
We believe that the depression of U.S. business activity will amount to 1 1/2 to 2 1/2 years (6 to 10 quarters) of low or negative economic growth, and a peak to trough decline in GDP of about 10%. Unemployment could exceed 10%. We expect world business activity to shrink to very low or negative growth for about the same period of time.
There are three events which could deepen and prolong the mild depression and turn it into a much more serious and long lasting problem:
1. Over the counter derivatives could continue to collapse. For example more Lehman and AIG credit default swaps, or other bad derivatives. How many more land mines like this exist out there?
2. Banking liquidity, which is slowly starting to return to the banking system, could fail to be absorbed and banks could continue to refuse to lend.
3. A trade war could break out, debilitating global trade and destroying growth.
Assuming that none of these occur, we expect to have global growth return within a year or two. After some rude shocks, the markets will once again rise.
INFLATION VERSUS DEFLATION
Everyone agrees that money supply and the monetary base are growing in almost all countries. Deflation proponents say that this does not matter, because until the velocity of money accelerates again, inflation will not rise much. They argue that the money may be going into the banking system, but it is not moving into the economy, so it is unable to create inflation. Some in this group state that until employment rises, the velocity of money will not rise, and inflation will not be a problem.
A second group, lets call them disinflationists, not deflationists, say that the governments of the world will eventually mop up the excess money supply, with monetary actions meant to reduce the danger of inflation. This excuse has been used repeatedly, prior to the advent of past inflationary episodes. It is an interesting theory, but it never seems to happen in practice. Somehow, the politicians never feel that mopping up excess monetary creation is so important…and by the way, it is not trivial to accomplish.
Although the first argument has some good points, it fails to note that the U.S. is not the only country in the world with rapid monetary growth. Many other countries have a much stronger velocity of money than the U.S. Further, the analysis is complicated by the need for countries to sterilize foreign purchases of their currency (by printing money), and by many other variables.
Inflation caused by fiscal policy is another problem that few seem to be mentioning. Fiscal policy which expands deficits, and creates liquidity through various types of handouts, also creates growth in the money supply. It can even circumvent the banking system, adding money through non bank transfers. In our opinion, we will be seeing much more inflation caused by fiscal policy created in many countries around the globe.
After weighing numerous variables, we continue to believe that after a period of moderating inflation, that new inflationary problems will arise before employment begins to rise.
GLOBAL MARKETS ARE RALLYING
In spite of negativity from many quarters, stocks, currencies and commodities are rallying globally. Governments are buying stocks, sometimes secretly, sometimes openly (several countries, including Russia have announced that they are buying stocks). Other countries are supporting their currencies and buying stocks more discreetly. Many experienced observers think that the current market rally may last for several weeks.
No national government wants a plummeting currency or a plummeting stock market, and they are trying to stop the chaos, panic, and forced liquidation. We can be certain that if further bouts of forced liquidation and panic occur, governments will come in to support their currencies and to buy stocks.
Such intervention will create only short term positive effects. It may create a currency or stock market rally, but not a new bull market. It is not a long term solution. Projected economic growth must return before there will be a long term rally.
When it occurs, the long term rally will begin four to sixteen months before economic growth returns. Markets are discounting mechanisms. They discount economic growth or shrinkage that has not yet occurred. For example, the recent decline from last October until last week, was discounting the slow and negative economic growth that began months ago, and is just now starting to be recognized by the public. The pattern that has been most frequently seen in the past, after panics and capitulations such as the one we saw in October, is the market will first stage a rally, and then probably experience a retest of the recent correction. The rally and correction will be part of a base building period.
Pessimism is rampant now, and many people are ready to get out and be done with stocks, commodities and currencies for good. This type of psychology is often seen just as rallies begin. We expect the rally in stocks, gold, commodities, and currencies to continue for a while longer.
Thanks for listening.
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